The Bouncing Bear
he September volatility was a bit of a shock; the market had lulled us into a false sense of security. But let’s keep things in perspective: from the high on the 2nd September (453.19) to the low on the 4th October (428.64) the market tumbled 5.4%. That’s not even a correction which is a drop of 10%. However, it dropped decisively below the 50 day moving average (after having bounced off 6 times already this year) and even closed below the 100 day moving average on 2 occasions.
Even so, we were never close to a bear market (SPY less than 362.55) or even our ITM OUT signal, the 10/200 death cross. SPY would have to drop to around 415 for that to be triggered.
Now we are currently trading at 445.87 which is only 1.6% below the all-time high. Can it continue to go up? That is anybody’s guess.
The market does seem to have got over its swoon and be heading up again – although that is just my observation. No-one knows exactly what the market is going to do. But there are some indications that this is what is probably going to happen:
- SPY has formed an inverse head-and-shoulders pattern. It is small, lasting only a month and the neckline is skewed but it is a bullish sign. (Top chart)
- The MACD histogram is positive and increasing – also a bullish sign. (Middle Chart)
- On Balance Volume has bottomed and is heading up – also bullish (Bottom Chart)
- A 10/50 golden cross, and 10/50/100 all trading above the 200 SMA – also bullish
The MACD is an indicator I didn’t cover in the ITM bull strategy book, but it is an integral part of the ITM bear strategy. I will be going through it in the ITM bear book, along with the parameters that we will be using as a signal. And I am still on track for publishing the bear strategy book in November.
Choosing Your Options
When I started to write ITM the SPY was very much lower than it is today. I thought that a $10K account to start off seemed like a nice round number, and as SPY was at that time just over 300 there was no problem getting calls to fit the ITM criteria within an account that size.
Who knew that SPY was going to shoot up to 450 in less than 2 years? I certainly didn’t.
Today, SPY is trading at 445.87. When choosing an option, we want to have an effective price less than 1% away. In other words the premium plus the strike must be less than $450.33. Looking at the current options prices:
f we look at the 300 strike which is 66% of the current price, we see that if fits the criteria, but we would need over $14K to buy the option. Even having a closer expiry date doesn’t really help us much. But it is a good choice: a high delta and an effective price only 0.1% away from the current choice.
The 345 and 350 strikes also fit the criteria, but for the fact that they have an expiry date only 3 months away. This is not necessarily a bad thing; it just means that you must roll out 3 or 4 times a year rather than just once. But in a strongly-moving market this is quite a good thing because you can roll up at the same time.
The problem with the 345 and 350 strike is that you are getting close to the current price, and you are much safer with an option that is deeper in the money. On the other hand, if SPY continues to go up you will have better returns. It really comes down to what risk profile you want. Personally, I would go with the 300 – if your account stretches to it.
Remember, this is a general observation not financial advice. I am not a financial adviser. Only you can determine your risk tolerance.
Happy Trading!
